Volume 3, Number 1, January March

STANDARD

ISSN (P):2319-9059, (O):2319-9067

Satyanarayan Kishan Kothe 7

ABSTRACT

been experienced due to services revolution taken p

growth of output and that is due to various factors including strong and consistent external demand for services. In this
context, the demand for exports of services from global consumers has great importance. The estimation of external demand
for services would enable us to measure the price and income elasticity of export demand. The present study attempts to
estimate the standard export demand function, which ultimately estimates the income and price elasticity of export demand. It
also endeavors to find whether structural change causes to change price and income elasticity of demand for services exports
between pre and post liberalized period. In addition, is tried to understand the effect of liberalization on demand for exports of
services.
KEYWORDS
Standard Export Demand Function, Price Elasticity of Demand, Exports, Income Elasticity of Demand, Structural
Changes In Export Demand etc.
INTRODUCTION
Export is generally considered to play an important role in the economic development of a country. In particular, Kothe and
Kouthe (2009) found that the services exports have significant impact over the economic growth in India for the period 1990-91
to 2007-08. Which it underlines the role of services exports and the need for improvisation in services exports growth for the
sustainable growth in India that is led by services.
Kothe and Sawant (2010) proclaimed that besides the contribution in GDP, services exports also have favorable impact on
-95,
however the deficit in overall balance of payments faded off after 1995 due to surplus in trade in services. Kothe (2012) marked
services sector provides a very stable growth of output and that is due to various factors including strong and consistent
external demand for services. In this context, the demand for exports of services from global consumers has to be estimated. The
estimation of external demand for services would enable us to measure the price and income elasticity of export demand.
measuring the income and price elasticities of foreign trade, especially in developing countries, have
received a great deal of attention because of its substantial implications on trade policy and balance of payments issues. Senhadji
and Montenegro (1999) also emphasized the importance of export demand elasticities. They further concluded that the higher the
income elasticity of export demand, the more powerful exports would be as an engine of growth. The higher the price elasticity,
the more competitive is the international market for exports of the particular country, and thus a real devaluation will be more
successful in promoting the export revenues. Accordingly, price and income elasticities of export demand become important for
investigating the effects of devaluation on trade balance. However, here we would compare the price and foreign income effects
of aggregate export demand for services to evaluate the pre and post liberalization changes in external demand for services in
response to the changes in the real effective exchange rate and world income.
Imbs and Mjean (2010) estimated trade elasticities that are governed by the demand side of the economy. The response of
aggregate imports and exports to changes in relative prices depends on consumers' willingness to substitute domestic and foreign
goods, just as it does in a venerable literature. They used a sectoral version of a conventional Constant Elasticity of Substitution
(CES) demand system to motivate a parsimonious and quasi-structural estimation of trade elasticities.
Barcenilla and Molero (2003) estimated price and income elasticities for services export flow as explanatory variable to find
evidence for non-price competitiveness in relation export demand in EU countries. Marquez (2005) estimated income and price
elasticities for exports and imports of four categories: travel, fares, transportation, and other private services. To assess
aggregation biases, he compared these elasticities to the ones associated with aggregate services. Lee, Bae and Seo (2008)
estimated the goods trade and services trade separately in order to confirm what kinds of differences exist in price and income
elasticities between the trade of goods and services.
ing
the export growth of a sector. As global incomes rise, the demand for normal and luxury products / services rises, while the
demand for inferior products/services declines. The income elasticity of demand for luxury products is expected to be greater than
one, while that for normal goods is expected to be between zero and one. The kind of products / services a country exports, i.e.,
7Assistant

Professor, Department of Economics, University of Mumbai, Maharashtra, India, kothesk@gmail.com

International Journal of Trade & Global Business Perspectives Pezzottaite Journals.

780 | P a g e

Volume 3, Number 1, January March

ISSN (P):2319-9059, (O):2319-9067

the income elasticity of demand of the product/services, is an important factor that determines the impact of external demand
shocks, like gl
determine the impact of global economic crises on exports. If the exported services are less price-sensitive, during an economic
slowdown, the opti
Das, et al. (2011) reviewed a vast bulk of literature estimating income/price elasticities for the export of goods, but very few
studies exist, especially for developing economies, that estimate the income elasticity for the export of services. Even fewer
studies exist that estimate the income elasticity for Indian services exports. The small number of empirical time-series studies that
exist on the determinants of the United States (US) export of services largely model export volumes in terms of foreign income
and the real exchange rate. These studies all show that conventional models of merchandise trade can be applied successfully to
the trade in services, as argued by Van Welsum (2003a). Recent examples of these studies include Huang and Viana (1995),
Wren-Lewis and Driver (1998), Deardorff et al. (2000), Ansari and Ojemakinde (2003), and Mann (2004).
Das, et al. (2011) confirm that most of these studies have found that the income elasticity of demand is above unity, while relative
price effects are comparatively small to those typically found for merchandise trade. For example, Wren-Lewis and Driver (1998)
used a number of different estimation techniques and found that the income elasticity of demand for the aggregate volume of
exports of services in the US lies in the range 1.50 1.95%, while the relative price elasticity lies in the range 0.21% to 0.40%.
The findings of Huang and Viana (1995), Deardorff et al. (2000), and Mann (2004) raise the possibility of heterogeneous income
and price elasticities for different categories of exports of services, although none of these studies seeks to test this explicitly.
Huang and Viana (1995) and Deardorff et al. (2000) both find much higher income and price elasticities of demand for passenger
fares and other travel-related exports, than for other categories of service exports. In a panel-data analysis of sub-categories of
business and technical services, Mann (2004) reports that relative price elasticities are typically insignificant and, in some cases,
are not negative as expected.
Das, et al. (2011) further concludes that the higher the income elasticity of export demand, the more powerful exports will be as
an engine of growth (See Houthakker and Magee, 1969 and Goldstein and Khan, 1985). Senhadji and Montenegro (1999) found
that the Asian countries had the highest estimated values for income elasticity among the developing and industrial countries. This
advocated the view that exports have been a powerful engine for growth in the Asian region. This has an important implication:
the higher the income elasticity of export demand, the more severe will be the impact of a slowdown in growth of GDP on
developing countries exports and growth. The same is converged in the analysis made by Kothe and Kouthe (2009) that led to the
conclusion that services exports are emerged as an engine of economic growth in Indian context.
Pogany and Donnelly (1998) expounded in their study that the income elasticity of trade is defined as the percentage change in
trade, either for exports or for imports, with respect to a percentage change in income. The income elasticity of trade can be
defined either in aggregate terms or in terms of individual commodities and either for a single country, a region, or for the entire
world. For example, the aggregate global income elasticity of trade (AGIET) would be defined as the percentage change in world
imports (or exports), attributable to a percentage change in world income (or output), ceteris paribus. It measures all factors
affecting the expansion of trade, including reductions in transactions costs, increased trade liberalization, influences of economies
of scale due to globalization, and general growth in world income.
estimate income elasticities for aggregate services exports and exports of travel services, transportation services, financial
services, and software services. They used time-series data from 1970 2008. The present study attempts to estimate the standard
export demand function, which ultimately estimates the income and price elasticity of export demand. It also endeavors to find
whether structural change causes to change price and income elasticity of demand for services exports between pre and post
liberalized period.
METHODOLOGY AND DATA
. (2011) estimate the standard export
demand equation for India using data from 1970 2008. According to the standard export demand function, exports depend on
price competitiveness as measured by the real exchange rate, and on global income as measured by global GDP. And to measure
relative price, they looked at price and exchange rate data. The volume of exports depends on nominal exchange rates after
adjusting for the domestic level of inflation, through which, they arrived at the real effective exchange rate (REER). Real exports
of services are arrived at by deflating nominal exports with the GDP deflator. World GDP in real terms captures the income
effect. The estimated model by Das, Banga and Kumar (2011) is as follows:
(1)

t = 1970 to 2008
Where
is the log of real exports of Indian services to the world,
is the log of a product of effective exchange rate and relative prices.

is the log of real world GDP, and

International Journal of Trade & Global Business Perspectives Pezzottaite Journals.

781 | P a g e

Volume 3, Number 1, January March

ISSN (P):2319-9059, (O):2319-9067

The standard export demand function is considered herein for the measurement of response of price competitiveness and global
f
1961 to 1990 and 1991 to 2010. As the quantity demanded of services exports, which is basically required to measure any type of
elasticity of demand, cannot be measured, the reasons for that are first, the unit value index for trade in services are not computed,
second the services are heterogeneous in nature therefore the units of services cannot be defined. Therefore, the standard export
demand function estimated by Das, et al. (2011) is used herewith as the base model to measure the price and income effect on
export demand for services in pre and post liberalization period. This estimation is subject to the availability of data because
though all the dependent and independent variables that are available for the period of 1951 to 2010, the REER for the same
period is not available. According to Darvas (2012), the real effective exchange rate (REER), which measures the development of
le in both
theoretical and applied economic research and policy analysis. He further stated that it is used for a wide variety of purposes, such
as assessing the equilibrium value of a currency, the change in price or cost competitiveness, the drivers of trade flows, or
incentives for reallocation production between the tradable and the non-tradable sectors.
The RBI publishes the data on REER, but that is available for the period 1993-94 to 2010. In addition, that too is based on WPI,
(WPI) measure face limitations being the measure of wholesale prices of manufacturing goods,
which does not include the prices of services in the country, whereas Consumer Price Index (CPI) measure does include the prices
of some services. Therefore annual CPI-based real effective exchange rates (REER) for the period of 1961-2010 having trade
weight for 67 trading partners that is published by Darvas (2012) is used in the estimation.
Das, et al. (2011) suggested a basic model of the standard export demand function. We have estimated herewith one model as
suggested by Das, et al. and the other attempted to find structural change in the said function in pre and post liberalization period.
In the present context among the two approaches to find the structural change i.e. Chow test (1960) and dummy variable approach
by Gujarati (1970) the latter is followed as earlier while estimating the standard export demand function and comparing for the
two above mentioned periods for structural changes, if any. Therefore, the standard export demand function as suggested by Das
et al (2011) is the same as equation (1). In addition, the other standard export demand function is estimated using dummy variable
approach for comparison of the two above mentioned periods for structural changes by Gujarati (1970) as follows:
(2)
t = 1961 to 2010
As earlier,
is the log of real exports of Indian services to the world,
is the log of real world GDP, and
is the log of a product of effective exchange rate and relative prices.
is dummy variable associated with GDPw and
REER which define
for pre and
for post liberalization period.
All the variables at level i.e. exports of services from India (EXPSERi), world GDP (GDPw), real exchange rate (REER), dummy
variable (D1) and its product with world GDP (D1GDPw) and real exchange (D1REER) are tested for stationarity, as the variables
form time series, with the help of augmented Dickey Fuller (ADF) (1979) and Phillips-Perron (1988) test for unit root. In
addition, both the tests confirmed that all the variables found to be non-stationary at level.
As mentioned earlier if all the variables in regression are found to be non-stationary then Engle-Granger test (1987) for a
cointegrating regression can be used for the estimation. Therefore, it is followed to estimate log linear regression to find the
standard export demand function, which ultimately estimates the income, and price elasticity of export demand as it is exercised
by Das, et al. (2011). Such a regression may be called the static or long run standard export demand function and interpret its
parameters as long run parameters. Therefore, the parameters represent long run income and price elasticity of export demand.
Moreover it is also attempted to find the change in elasticity are due to structural change, if any, between pre and post liberalized
period by including dummy variable to distinguish the period.
RESULTS AND CONCLUSIONS
We estimated the above equations (1) and (2) to measure the income and price elasticity of export demand from India by world.
We get three expressions of estimates from above equation (1) and (2) that are summarized in the table 1 at the end. The results
o the
changes in prices, though both of the two elasticities are found to be significant for the period of 1961 to 2010. A 1 per cent
increase in world GDP lead to 4.25 per cent increase in services export from India to world and 1 per cent decline in price in
Indian market lead to 1 per cent increase in demand for services exports by world. The income elasticity of demand for services
exports by world measured by Das et al. (2011) is 3.22 for the period of 1970-2008. Though there is difference between authors
e
REER. However, both the measures convince that positive change in world income converts demand for services exports more
proportionately. Therefore, we can conclude that Indian services are world income elastic. In addition, as Das also pointed out
International Journal of Trade & Global Business Perspectives Pezzottaite Journals.

782 | P a g e

Volume 3, Number 1, January March

ISSN (P):2319-9059, (O):2319-9067

those services from India need to be more price competitive, we reiterate that price competitiveness could be more effective to
attract more demand for services exports from world.
The interesting part of the estimation is that the structural change in demand for services exports from India after liberalization.
It is
undoubtedly true that there has been significant change in income elasticity of demand for services between pre and postliberalized period. The demand for services in world market, after 1991, has been more income elastic than that of the period 1970
to 1990. Therefore, it can be firmly stated that liberalization has positive impact on services exports in India. Burange, et al.
(2009) concludes that services exports in the post-reform period have witnessed tremendous growth. Kothe and Kouthe (2009)
accorded that India has been most benefitted economy from the agreements of GATS among the emerging economies and that is
evident from the positive impact of services exports on economic growth in India during 1990-91 to 2007-08. Whereas Kothe
(2012) finds significant impact of trade in services on services revolution and solicits that services revolution in India is caused by
process of globalization along with other determinants of services revolution. Gordon and Gupta (2003) also states that economic
reforms in 1990s lead to four-fold rise in services exports during 1980 to 2002. Therefore, the structural changes in demand for
services exports are due to economic reforms. That too is underlined by many Singh (2004), Murthy (2004) and by Basu (2004)
though in terms of growth of services exports guided by IT sector. Basu (2004) further states, The reforms of the early 1990s,
luck (as in the rise of IT in the United States) and history (such as the overinvestment in higher education) seem to be going in
The depreciation of rupee in 1990s has also been benefitted in bringing more dollars to India from exports of services that started
sharing increasing part of external earnings. The price elasticity of demand for services exports during 1961 to 1990 was as good
as zero. That reflects the non-competitiveness of services in terms of prices. That means reduction in prices of services did not
attract demand at all. So that it can be said that the demand for exports by world was price inelastic whereas price is the most
important determinant of any good or service. Nevertheless,
became responsive to the changes in prices in domestic market though less proportionately. Das, et al. (2011) also noted that the
price elasticity inter-alias captures the eff
exports growth cannot be improved through its price competitiveness. Hence,
enhancing the quality of services rather th
upgraded and broader services rather than competing on price alone. A very highly productive and efficient infrastructure required
for services industry that converts the competence of the services in world market could change the responsiveness of demand for
export due to change in price significantly.
REFERENCES
1.
2.
3.
4.
5.
6.
7.
8.
9.

Ansari, M. I. & Ojemakinde, A. (2003). Explaining Asymmetry in the US Merchandise and Service Account Balance:
Does the Service Sector Hold the Key to the US Current Account Woes? The International Trade Journal 17(1), 51 80.
Barcenilla, S. & Molero, J. (2003). Service Export Flows: Empirical Evidence for the European Union, SETI Project,
Universidad de Zaragoza and Universidad Complutense de Madrid, May, 2003.
Basu, K. (ed.) (2004). India's Emerging Economy: Performance and Prospects in the 1990s and Beyond, MIT Press
Books, The MIT Press.
Burange, L.G., Chaddha, S. J. & Kapoor, P. (2009).

s Trade in Services, Working Paper, No.: UDE31/3/2009

Darvas, Z. (2012). Real Effective Exchange Rates for 178 Countries: A New Database, Working Paper 2012/06,
Bruegel, 15 March 2012 accessed on 15th Dec. 2012
Das, A., D, Banga, R. & Kumar, D. (2011). Global Economic Crisis: Impact and Restructuring of the Services Sector in
India. ADBI Working Paper 311. Tokyo: Asian Development Bank Institute.

Deardorff, A.V., Hymans, S.H., Stern, R.M. & Xiang, C. (2000). Forecasting U.S. Trade in Services, Working Papers
467, Research Seminar in International Economics, University of Michigan.

Falvey, R. E., & Gemmell, N. (1991). Explaining Service Price Differences in International Comparisons, American
Economic Review, 81, 1295-1309, 1991.
Falvey, R. E. & Gemmell, N. (1996). Are Services Income-Elastic? Some New Evidence. Review of Income and
Wealth, 42: 257 269. doi: 10.1111/j.1475-4991.1996.tb00182.x

10. Goldstein, M. & Khan, M. S. (1985). Income and Price Effects in Foreign trade. In Handbook of International
Economics. Vol. 2, edited by R. Jones and P. Kenen. North-Holland, Amsterdam.

11. Houthakker, H, S. & Magee, S. P. (1969). Income and Price Elasticities in World Trade. Review of Economics and
Statistics 51(2): 111 125.

International Journal of Trade & Global Business Perspectives Pezzottaite Journals.

783 | P a g e

Volume 3, Number 1, January March

ISSN (P):2319-9059, (O):2319-9067

12. Huang, J. H. & Viana, S. (1995). Modelling US Services Trade Flows: A Cointegration-ECM Approach. Research
Paper No. 9518. Federal Reserve Bank of New York.
13. Imbs, J. & Mjean, I. (2010). Trade elasticities. Paris School of Economics, unpublished mimeo.
14. Kothe, S. K. (2012a). Globalization and S
Bhartiya Arthvyavasthetil Sthityantare by The Annual Conference of Marathwada Arthshastra Parishad, February 2012,
197-202. ISBN 978-81-908303-2-4.

15. Kothe, S. K. (2012b). Inter-Sectoral Shifts in Employment and Employment Elasticity in Service Sector in India.
International Journal of Development Studies and Research, Vol.1, No.1 May-July 2012, 159-167.
16. Kothe S. K. & Kouthe, P. K. (2009). Services Exports and Economic Growth: Is there any Causality? A Case Study of
28th and 29th March 2009.
17. Kothe, S. K. & Sawant, A. (2010). Global Financial Crisis and FDI in Services Sector in India. In Arockia Baskaran & J
J Soundararaj (Eds), The Impact of Foreign Direct Investment on Indian Economy, Excel Books, May 2010. pp. 259268.
18. Lee, M., Bae, J. & Seo, M. (2008). An Empirical Study on the Different Effects of Income and Price Elasticities in the
Korean Goods and Services Account Balance, Journal of Korean Trade, Vol. 11, No.3, 2008.
19. Mahadevan, R. & Kalirajan, K. P. (2002). How Income Elastic Is The Consumers Demand For Services In Singapore?
International Economic Journal, Vol.16, No. 1, 2002, pages 95-104
20. Mann, C. L. (2004). The US Current Account, New Economy Services and Implications for Sustainability. Review of
International Economics 12: 262 276.
21. Marquez, J. (2005). Estimating Elasticities for U.S. Trade in Services, International Finance Discussion Papers, Number
836, August 2005, Board of Governors of the Federal Reserve System.
22. Murthy, N.R.N. (2004). The Impact of Economic Reforms on Industry in India: A Case Study of the Software Industry.
In Basu, K. (ed.), India's Emerging Economy: Performance and Prospects in the 1990s and Beyond, MIT Press Books,
The MIT Press.
23. Senhadji, A. S. & Montenegro, C. E. (1999). Time Series Analysis of Export Demand Equations: A Cross-Country
Analysis. IMF Staff Papers 46(3), 259 273.
24. Singh,
Economy: Performance and Prospects in the 1990s and Beyond, MIT Press Books, The MIT Press.
25. Summers, R. (1985). Services in the International Economy, In R. P. Inman (ed.), Managing the Service Economy.
Problems and Prospects, Cambridge University Press, Cambridge, 1985.
26. Van Welsum, D. (2003a). International Trade in Services: Issues and Concepts. Economics Working Paper 04/03,
Birkbeck College, School of Economics, Mathematics and Statistics.
27. Pogany, P. & Donnelly, W. A. (1998). The Income Elasticity of Trade: Theory, Evidence, and Implications, Working
Paper No. 98-09-A-Revised, Office of Economics Working Paper, U.S. International Trade Commission.
28. Wren-Lewis, S. & Driver, R. (1998). Real Exchange Rates for the Year 2000, Policy Analyses in International
Economics No. 54. Institute for International Economics.
Annexure
Table-1: Income and Price Elasticity of Demand for Exports of Services
Period

Income Elasticity of Demand

Price Elasticity of Demand
for Exports of Services
for Exports of Services
1961 to 2010
4.25
1.00
1961 to 1990
2.83
-0.08
1991 to 2010
5.68
0.40
Note: All the measures are significant at 5 per cent level of Significance.
Sources
International Journal of Trade & Global Business Perspectives Pezzottaite Journals.

784 | P a g e